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TriDelta Investment Counsel Q3 Review – US Government Battles – What Now?

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As we write this, the US government is locked in a battle around whether to increase its debt limit. Some government workers are taking a forced vacation, and if agreement is not reached by the October 17th deadline, the US could default on its debt in the week or two after that date.

Our general approach has been to be a little cautious heading into Q4, with higher cash weightings (approximately 10%) and even a purchase of an inverse ETF (we bought an ETF that will go up in value if the US S&P500 goes down in value).

We anticipate that the fear factor will build over the month as CNN and Fox News focus on an ‘impending’ US default that we believe to be highly unlikely.

We also anticipate that the height of this fear will likely create short-term market pullbacks that will be a great time for us to buy some cheap stocks.

Traditionally, November, December and January have been some of the best months of the year for the market, and we see a decent rally coming off of the almost inevitable decision for the US to raise their debt ceiling, and stave off a default… at least until the next debt ceiling deadline sometime in 2014.

Review of Q3

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As we review the third quarter of 2013, the numbers showed stable to solid stock performance and flat to negative bond and preferred share performance.

TriDelta clients had net gains in the range of 1% to 2.5% over the quarter (annualized at 4% to 10%).  Clients with a greater growth focus (higher stock weighting) were closer to 2.5% and those with more conservative goals (higher bond weighting) were closer to 1%.

In the North American stock markets, we saw Canadian stocks outperform the US by over 3% in the quarter.  This was the first quarter in quite a while where Canada outperformed.  There is certainly some belief that metals, mining and energy stocks are undervalued at the moment, and have an opportunity to outperform other parts of the market – although the timing of this remains to be seen.

Weakness continued on the Utilities and Telcos front vs. other sectors.

Our best performing holdings in the quarter were:

  • Home Capital up 30%
  • Priceline up 19%
  • Suncor up 19%
  • Two strong purchases this quarter were Goodyear Tires and Transcontinental – both up 17% so far.

Our worst performing holdings in the quarter were:

  • Potash down 17% (we decided to sell the stock after the market closed but before the announcement that the Russian potash cartel was dissolving – unfortunately by the time the market opened the stock had already fallen)
  • Trilogy Energy down 17%

Dividend Changes

Given our focus on dividend growth, we report on all dividend changes in the quarter.  Once again there were no declines in dividends in any of our holdings, while a few companies did have a dividend increase.

 

Company Name % Dividend Increase
Home Capital +7.7%
Royal Bank +6.4%
McDonalds +5.2%
TD Bank +4.9%
Norfolk Southern +4.0%
Bank of Nova Scotia +3.3%
Verizon +2.9%

 

Goodyear Tires initiated a $0.05 dividend that pays on Oct 30, 2013 after not paying a dividend for many years.  This puts its yield at a little under 1%.

On the bond front, we continued to outperform the bond and preferred share indices, but net returns were very flat over the quarter, with weak returns in July and August, and some recovery in September.

With preferred shares, we saw a tale of 3 stories in the quarter.  Somewhat surprisingly, rate reset preferred shares index lost 1.5% in the quarter, floating rate preferreds lost 1.8%, while fixed rate preferreds were actually up 0.2%.    We have taken a little heat for being overweight fixed rate preferreds, but given the view of short term rates holding for at least another 1 to 2 years, floating rate preferreds make little sense at the moment.  We also believe that 10 year interest rates will be trading in a range for a while, which will likely put fixed rate preferreds at a slight advantage.

It should also be noted that 10 year Government of Canada interest rates actually declined a full 25 basis points (0.25%) in late September.  We feel that this is a real sign that long term interest rates are unlikely to rise in the near time and there will likely be several opportunities for gains in bonds as rates wax and wane.

What we see in Q4

  • We remain cautious in the very near term as the US government politicians play ping pong
  • We will look to add stocks on pull backs
  • For now, we will keep the short S&P ETF
  • Valuations are fair overall, but are a little stretched on some of the less cyclical names (utilities, telcos, etc.) leaving greater opportunity in the cyclicals (financials, metals, consumer discretionary) as long as the economy doesn’t stall out.

Our worst case scenario for the US government is actually quite positive for bonds.  While we believe it is very unlikely that there will be a lengthy government shutdown and extremely unlikely to see a default, given the fragility of the current economic rebound, it would not be a stretch to even consider the possibility of a quick dip back into the recessionary zone.  The last government shutdown occurred in 1995/96 during an episode of better economic circumstances, and had essentially negligible economic impact, but long-bonds rallied.

In the short term we believe that US economic fears will lead to delays in US bond buying tapering and push off any risks of interest rate increases.

Summary

The markets move on fear and greed.

Fortunately, in the world of 2013, we can count on the media to intensify both of those emotions when the time is right – although the media does ‘fear’ much better.  We believe that by keeping our emotions in check, there will be opportunities to take advantage of this media enhanced fear.

We believe that October may be one of the best examples of this.

 

TriDelta Investment Management Committee

Cameron Winser

VP, Equities

Edward Jong

VP, Fixed Income

Ted Rechtshaffen

President and CEO

Anton Tucker

Executive VP

Lorne Zeiler

VP, Wealth Advisor

 
 

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